The Nature and Sources of Competitive Advantage

1. The Nature and Sources of Competitive Advantage • The emergence of competitive advantage • Sustaining competitive advantage • Competitive advantage in different market settings • Types of competitive advantage: cost and differentiation OUTLINE

2. What is competitive advantage? • The potential to earn a persistently high rate of profit • Not the same as profitability • Long term investments may not show up in short term profits • Investing in market share, technology, customer loyalty or even executive perks

3. The Emergence of Competitive Advantage How does competitive advantage emerge? • External sources of • change e.g.: • Changing customer demand • Changing prices • Technological change Internal sources of change Some firms have greater creative and innovative capability Resource heterogeneity among firms means differential impact Some firms faster and more effective in exploiting change (Time-based competition)

4. Competitive Advantage from Internally-Generated Change: Strategic Innovation • Many argue innovation is the only remaining source of competitive advantage (e.g. Hamel) • Kao (2007) Innovation Nation: How America is Losing its Innovation Edge, Friedman (2005) The World is Flat • Talent is everywhere, capital is everywhere, Silicon valley is everywhere Characteristics of innovation strategies: • Associated with new entrants to an industry (e.g. Nucor in steel, IKEA in furniture, Home Depot in DIY, Dell in PCs, American Apparel in casual clothing) • Reconcile conflicting performance goals(e.g. Toyota’s lean production system combines low cost, high quality, and flexibility. Retailers Primark and Target combine low cost with stylishness.) • Reconfiguring the value chaine.g.--- • Nike’s system for manufacturing and distributing shoes totally different from traditional shoe manufacturer • Southwest Airlines simplification of the normal airline value chain • Zara’s system of design, manufacture, and distribution

5. Sustaining Competitive Advantage Against Imitation ISOLATING MECHANISM REQUIREMENT FOR IMITATION Identification - Obscure superior performance - Deterrence--signal aggressive Incentives for imitation intentions to imitators - Pre-emption--exploit all available investment opportunities - Rely upon multiple sources of Diagnosis competitive advantage to create “causal ambiguity” - Base competitive advantage upon Resource acquisition resources and capabilities that are immobile and difficult to replicate

6. Competitive Advantage in Different Industry Settings: Trading Markets and Production Markets SOURCE OF IMPERFECT COMPETITION OPPORTUNITY FOR COMPETITIVE ADVANTAGE MARKET TYPE • None (efficient markets) • Imperfect information • Transactions costs • Systematic behavioral trends • Overshooting None Insider trading Cost minimization Superior diagnosis (e.g. chart analysis) Contrarianism TRADING MARKETS Identify potential barriers to imitation (e.g. deterrence, preemption, causal ambiguity, resource immobility, etc.) & base strategy upon them. Difficult to influence or exploit. • Barriers to imitation • Barriers to innovation PRODUCTION MARKETS

7. Sources of Competitive Advantage COST ADVANTAGE Similar product at lower cost COMPETITIVE ADVANTAGE Price premium from unique product DIFFERENTIATION ADVANTAGE Concept of “stuck in the middle”

8. Porter’s Generic Strategies SOURCE OF COMPETITIVE ADVANTAGE Low cost Differentiation Industry-wide COST DIFFERENTIATION COMPETITIVE LEADERSHIP SCOPE Single SegmentFOCUS

9. Features of Cost Leadership and Differentiation Strategies Generic strategy Key strategy elements Resource & organizational requirements COST Scale-efficient plants. Access to capital. Process LEADERSHIP Design for manufacture. engineering skills. Frequent Control of overheads & reports. Tight cost control. R&D. Avoidance of Specialization of jobs and marginal customer functions. Incentives for accounts. quantitative targets. DIFFERENTIATION Emphasis on branding Marketing. Product and brand advertising, engineering. Creativity. design, service, and Product R&D quality. Qualitative measurement and incentives. Strong cross-functional coordination.

10. Cost Advantage • Economies of experience curve and the benefits of market share • Sources of cost advantage • Using the value chain to analyze costs • Current approaches to managing costs OUTLINE

11. The Experience Curve The “Law of Experience” The unit cost value added to a standard product declines by a constant % (typically 20-30%) each time cumulative output doubles. 1992 1994 Cost per unit of output (in real $) 1996 1998 2000 2002 2004 Cumulative Output

12. Examples of Experience Curves Japanese clocks & watches, 1962-72 UK refrigerators, 1957-71 1960 Yen 15K 20K 30K Price Index 50 100 200 300 75% 70% slope 100K 200K 500K 1,000K 5 10 50 Accumulated unit production Accumulated units (millions) (millions)

13. The Importance of Market Share • If all firms in an industry have the same experience curve, then: • Change inrelative costs over time = f (relative market share) • This implies that market share is linked to profitability. This is confirmed by PIMS data: ROS (%) -2 0 5 10 0-10 10-20 20-30 30-40 over 40 Market Share (%) BUT: - Association does not imply causation - Costs of acquiring market share offset the returns to market share

14. Drivers of Cost Advantage • Indivisibilities • Specialization and division of labor ECONOMIES OF SCALE • Increased dexterity • Improved organizational routines ECONOMIES OF LEARNING • Process innovation • Reengineering business processes PRODUCTION TECHNIQUES • Standardizing designs & components • Design for manufacture PRODUCT DESIGN • Location advantages • Ownership of low-cost inputs • Non-union labor • Bargaining power INPUT COSTS CAPACITY UTILIZATION • Ratio of fixed to variable costs • Speed of capacity adjustment • Organizational slack; Motivation & • culture; Managerial efficiency RESIDUAL EFFICIENCY

15. Economies of Scale: The Long-Run Cost Curve for a Plant Sources of scale economies: - technical input/output relationships - indivisibilities - specialization Cost per unit of output Units of output per period Minimum Efficient Plant Size: the point where most scale economies are exhausted

16. The Costs Developing New Car Models(including plant tooling) $ billion Ford Mondeo / Contour 6 GM Saturn 5 Ford Taurus (1996 model) 2.8 Ford Escort (newmodel 1996) 2 Renault Clio (1999 model) 1.3 Chrysler Neon 1.3 Honda Accord (1997 model) 0.6 BMW Mini 0.5 Rolls Royce Phantom (2003 model) 0.3

17. Scale Economies in Advertising: U.S. Soft Drinks Despite the massive advertising budgets of brand leaders Coke and Pepsi, their main brands incur lower advertising costs per unit of sales than their smaller rivals. Schweppes SF Dr. Pepper Tab Diet Pepsi Diet 7-Up Diet Rite Advertising Expenditure ($ per case) 0.02 0.05 0.10 0.15 0.20 Fresca Seven Up Dr. Pepper Sprite Pepsi Coke 10 20 50 100 200 500 1,000 Annual sales volume (millions of cases)

18. Cost Advantage in Short-Haul Passenger Air Transport Costs per Available Seat-Mile Southwest Airlines United Airlines (cents) (cents) Wages and benefits 2.4 3.5 Fuel and oil 1.1 1.1 Aircraft ownership 0.7 0.8 Aircraft maintenance 0.6 0.3 Commissions on ticket sales 0.5 1.0 Advertising 0.2 0.2 Food and beverage 0.0 0.5 Other 1.7 3.1 Total 7.2 10.5

19. Applying the Value Chain to Cost Analysis: The Case of Automobile Manufacture STAGE 1. IDENTIFY THE PRINCIPAL ACTIVITIES R&D DESIGN ENGNRNG TESTING, QUALITY CONTROL GOODS INVEN- TORIES SALES & MKITG DEALER & CUSTOMER SUPPORT PARTS INVEN- TORIES DISTRI- BUTION PURCH- ASING COMPONENT MFR ASSEMBLY STAGE 2. ALLOCATE TOTAL COSTS

20. Applying the Value Chain to Cost Analysis: The Case of Automobile Manufacture (continued) --Plant scale for each-- Level of quality targets-- No. of dealers component -- Frequency of defects-- Sales / dealer -- Process technology -- Level of dealer -- Plant location support -- Run length -- Frequency of defects -- Capacity utilization under warranty STAGE 3. IDENTIFY COST DRIVERS PARTS INVEN- TORIES R&D DESIGN ENGNRNG TESTING, QUALITY CONTROL GOODS INVEN- TORIES PURCH- ASING COMPONENT MFR SALES & MKITG ASSEMBLY DISTRI- BUTION DEALER & CUSTOMER SUPPORT Prices paid --Size of commitment-- Plant scale --Cyclicality & depend on: --Productivity of -- Flexibility of production predictabilityof sales -- Order size R&D/design -- No. of models perplant --Customers’ --Purchases per --No. & frequency of new -- Degree of automation willingness to wait supplier models-- Sales / model -- Bargaining power-- Wage levels -- Supplier location -- Capacity utilization

21. Applying the Value Chain to Cost Analysis: The Case of Automobile Manufacture (continued) STAGE 4. IDENTIFY LINKAGES PRCHSNG PARTS R&D COMPONENT ASSEM- TESTING GOODS SALES DSTRBTN DLR INVNTRS DESIGN MFR BLY QUALITY INV MKTG CTMR Designing different models around common components and platforms reduces manufacturing costs Consolidation of orders to increase discounts, increases inventories Higher quality parts and materials reduces costs of defects at later stages Higher quality in manufacturing reduces warranty costs STAGE 5. RECCOMENDATIONS FOR COST REDUCTION

22. Dynamic vs. Static Approaches to Manufacturing DYNAMIC (Artisan Mode) STATIC (Scientific Management Mode) • problem solving • people matched to tasks • create employee knowledge • employees control production • customer orientation • quest for “one best way” • planning & control by staff • Incentives and penalties to ensure conformity to objectives PRODUCTION SYSTEM • continuous, incremental improvement • market needs pull technology • product and process innovation • teamwork and cross- • functional collaboration • science driven • focused around corporate R&D departments • emphasis on big projects MANAGEMENT OF TECHNOLOGY

23. Recent Approaches to Cost Reduction Dramatic changes in strategy and structure to adjust to the business conditions of the 1990’s Key elements: • Plant closures • Outsourcing • Delayering and cuts in administrative staff The fundamental rethinking and radical redesign of business processes to achieve dynamic improvements in performance. e.g.:- • Several jobs combined into one • Steps of a process combined in natural order • Minimizing steps, controls, and reconciliation • Use case managers as single points of contact • Hybrid centralization/ decentralization CORPORATE RESTRUCTURING BUSINESS PROCESS REENGINEERING “Obliterate don’t automate”

24. Harley Davidson Case • Identify Harley-Davidson’s strategy and explain its rationale. • Compare Harley-Davidson’s resources and capabilities with those of Honda. What does your analysis imply for • Harley’s potential to establish cost and differentiation advantage over Honda? • What threats to continued success does Harley-Davidson face? • How can Harley-Davidson sustain and enhance its competitive position?